Buy To Let: Do the maths

Nobody likes doing sums, and most of us stop doing them the instant we leave school. But property investors who fail to make the right calculations before buying will lose out.

It's easy to fall under the spell of the smooth salesman in the luxurious marketing suite, but running his figures through your calculator may expose the little tricks they use to make the investment look a much better proposition than it really is.

"Too often people don't bother to sit down and make their own calculations," says David Lawrenson of Landlordzone.co.uk. "They just believe what the developers tell them which is, frankly, often rubbish."

Developers tend to predict absurdly optimistic rents, and "forget" the costs and the empty periods between lettings, Lawrenson says. The only way to make sure an investment will work is to do the sums yourself. It is not difficult, and it is not necessary to be accurate to three decimal places, but it could make the difference between a secure future and losing your savings.

The first calculation is yield, the percentage return you make on the money you put in.

Divide annual income by property value, then multiply by 100.

To get the income, you take the rent and subtract all the costs, including the mortgage interest, letting agent's fees, ground rent and service charge (for leasehold flats), insurance, replacement fixtures and fittings and maintenance. Lawrenson also advises including an estimate of your own time and travel expenses – you are not doing this for charity, after all.

The importance of the yield calculation is that it shows you instantly if the property will earn you more than keeping the money in a building society account.

The next step is to calculate how much money you will need, and how much of this should be borrowed. Developers usually omit the extra costs in their "projected earnings" examples, Lawrenson says.

Total investment = cost of property + mortgage arrangement fee + legal costs + stamp duty land tax + survey + refurbishment + new furnishings.

You now know how much money you need. The next step is to calculate how much to borrow, and which type of loan will be best.

Buy-to-let mortgage broker Lee Grandin of Lettingagent.com and Landlord Mortgages points out that the mortgage repayments will be your biggest cost, so even small changes in interest rates can make a big difference to returns.

"In today's tough market it's important to make sure the figures genuinely stack up before committing, and yields are very reliant on the type of mortgage you choose," he says.

The basic choice is between repayment and interest-only mortgages, where the sum borrowed must be repaid at the end of the term.

"The majority of our experienced landlords take out interest only mortgages and not repayment mortgages," Grandin says. "If you ask a landlord why, the most frequent reply is 'why should I repay the money? – I make money by borrowing money'."

For example, borrowing £100,000 to invest in property, which gives an annual return of 10 per cent, if the mortgage interest is only 6 per cent, this makes good business sense."

Getting the best deal is a matter of trawling through the rival offerings from the buy-to-let mortgage lenders. Grandin has developed a handy online mortgage calculator at www.buytoletmortgages.co.uk, which makes comparisons easy – just enter the figures and it shows instantly what deals are available.

When the investment has been made and the property bought, investors need to revisit their calculator regularly to ensure things are going to plan. At this point, they will want to check the capital growth.

Capital growth = selling price – legal fees – selling costs – taxes – buying cost.

It is here that many people fail to include taxes, mainly the dreaded capital gains tax, which may reduce their nest egg by as much as 40 per cent.

This is another reason for doing your sums – they highlight the pitfalls that wait for the unwary investor.